Despite a minor resurgence over the past month, the share price of Petrofac (PFC) has still underperformed the FTSE All-Share by almost 30 per cent over the past year, which looks increasingly at odds with the oil services firm's growth prospects. Admittedly, market sentiment towards the sector soured during the early part of this year and Petrofac has warned of modest growth in 2013. Nevertheless the relative performance of the group's shares has been somewhat baffling, particularly given the expansion of its order book. We think that the lukewarm attitude towards the shares can largely be put down to concerns about profit margins, but these are unlikely to persist due to a major new contract win. This leaves Petrofac, trading at a hefty 24 per cent discount to its peer-group forecast-earnings multiple, looking like an inexpensive long-term growth play.
- Record order book
- Margin mix improving
- Revenue visibility
- Enhanced opportunities in Mexico
- Sector markdown on Saipem
- Increasing borrowings
Sentiment towards the sector took a turn for the worse after Italy's Saipem, Europe's biggest oil services provider, issued a brace of unexpected profit warnings during the first half of this year. And despite an order backlog that had risen by over a fifth since December to a record $14.3bn (£9bn) by the half-year mark, analysts remained circumspect on the ability of Petrofac to grow earnings because of a preponderance of contracts in Abu Dhabi, which is viewed as a lower-margin geography.
There's nothing Petrofac can do about Saipem's woes, but recent success in securing a multi-billion dollar petrochemical contract in Kazakhstan (as part of a consortium) should alleviate concerns over margins, albeit from the final quarter of 2014 onwards. That’s because the revenue ramp-up from this higher-margin contract will proceed gradually through 2014, with profit recognition unlikely before early 2015. JPMorgan estimates that the construction phase of the KLPE petrochemical project should generate at least another $955m in revenues for Petrofac. It’s worth noting that, even prior to the lucrative new contract with Kazakhstan LG Poly Ethylene (KLPE) LLP, the group remained on track to meet its target of doubling 2010 earnings to more than $862m by 2015.
The KLPE deal, though welcome, wouldn't have come as a surprise to industry watchers. Since 2005, Petrofac's ECOM division has successfully delivered a number of high value projects in Kazakhstan, but the group has also established a strong presence in Mexico through production enhancement contracts. These have typically involved Petrofac receiving set fees from state-controlled PEMEX to optimise production from Mexico's ageing oil & gas fields. However, things may be about to change. The recent proposal by Mexico's President Enrique Pena Nieto to partially liberalise the country's energy markets would generate more competition for domestic contracts, and would offer distinct advantages for an established operator like Petrofac because of the expected surge in inward investment for oil & gas infrastructure - the principal aim of the president's proposal.
| PETROFAC (PFC) | ||||
|---|---|---|---|---|
| ORD PRICE: | 1,349p | MARKET VALUE: | £4.7bn | |
| TOUCH: | 1,349p-1,350p | 12-MONTH HIGH: | 1,752p | LOW: 1,160p |
| DIVIDEND YIELD: | 3.8% | PE RATIO: | 9 | |
| NET ASSET VALUE: | 463¢ † | NET DEBT: | 23% | |
| Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($bn) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2010 | 4.35 | 0.54 | 127 | 43.8 |
| 2011 | 5.80 | 0.68 | 159 | 54.6 |
| 2012 | 6.32 | 0.77 | 186 | 64.0 |
| 2013* | 6.76 | 0.85 | 197 | 68.0 |
| 2014* | 7.72 | 1.06 | 235 | 81.1 |
| % change | +14 | +24 | +19 | +19 |
Normal market size:2,000 Matched bargain trading Beta:1.23 £1 = $1.59 †Includes intangible assets of $505m, or 146¢ a share *Edison forecasts | ||||
Certainly, Petrofac's ability to bolster its margins over the next 12 months has been helped by a succession of new contracts awarded outside the UAE. Apart from the KLPE deal, Petrofac signed a memorandum of understanding with KazMunaiGas (KMG), a $95m maintenance contract by Gazprom Neft Badra, and a $120m agreement with Malaysia's PETRONAS. Again excluding KLPE, Broker Edison estimates that Petrofac should secure $2.8bn in contracts from its new business pipeline during the second half, although this is based on the lower end of its historic win rate - events since the half-year suggest this might turn out to be a conservative assumption.
Increased capital commitments to Petrofac's integrated energy services division means that net debt is predicted to more than double to around $833m (26 per cent of estimated net assets) by the end of 2015, but the group's cash-flows will benefit from July's deal that increased Petrofac's share of the Petrofac Emirates joint venture to 75 per cent.
